The Top to Bottom Trade of the Decade

The interesting news continues to come from two vastly different areas – the top and the bottom of the financial pyramid.

At the top, a small number of people are feeling the effects of credit squeeze. The people are few but the money is great. Nearly a half a trillions dollars’ worth of deals have been stuck…pushed back…or cancelled for lack of financing.

Not that the feds and the Wall Street hotshots aren’t doing all they can to make the deals flow. Bloomberg reports that the Fed ‘injected’ another $31.25 billion into the banking system yesterday. Still, the ‘deals, deals, deals’ at which we marveled earlier in the year seem to be very hard to do.

“Deals Boom Fizzles as Cheap Credit Fades,” says the WSJ.

The problem is that even though the feds are making money available, lenders are becoming reluctant to lend and borrowers are becoming reluctant to borrow. That’s why we see the London Inter-Bank Lending Rate – LIBOR – so far above the central banks’ base rates. The government, through central bank intervention, can set one rate. But the banks have one of their own. And right now, banks are wary about lending a lot of money to each other – because they can’t figure out what each other’s real financial situation is.

“We ran into the problem in our hedge funds,” reported our old friend John Mauldin, at dinner on Wednesday night. “The pricing mechanism for many of these investment positions broke down. No one knows exactly who owes what to whom. It will clear itself up, of course…but right now, people are a little scared.”

Meanwhile, down at the bottom of the financial pyramid the individual numbers are smaller, but the number of individuals is much greater.

Foreclosures hit another record high, says yesterday’s news. Here, too, the feds are ready to step in with more money. But lenders and borrowers have grown weary and skittish. Mortgage lenders continue to close their doors. And mortgage borrowers continue to miss payments. One in seven subprime mortgages are now in arrears.

This should reduce consumer spending…but there was no sign of it in yesterday’s news. Instead, Macy’s (NYSE:M) and Wal-Mart (NYSR:WMT) reported better-than-expected retail sales. Go figure.

While the central bankers make money available to distressed speculators, borrowers and Wall Street operators, they have another worry:

Yesterday, oil rose over $75. Wheat piled up above $8. And gold…yes…gold…soared up over $700.

In a credit deflation – which is what is happening at the top and bottom – you’d expect prices to fall. And so we do…expect prices on houses and financial assets, generally, to fall.

But what oil, wheat and gold are signaling is something else. They’re telling us to beware of inflation…and to watch out for the falling dollar.

Here at The Daily Reckoning, we do not really care for the hard work of investing…we are too busy watching what is going on. So, we try to take the sweat out of investing, by reducing it to one investment decision, one time, every 10 years. We call it the “Trade of the Decade.”

At the beginning of the current decade our “Trade of the Decade” was simply to sell the Dow and buy gold. This trade looked like a good one for the first two years of the decade. Then, as the Dow rose from its 2002 low, it looked less good. Now, it’s looking good again.

If you had held onto the Dow stocks you’d be slightly ahead in nominal terms…and slightly behind in real terms. (We haven’t done the calculation…but generally, the stock market has gone nowhere. Subtract inflation, commissions and taxes…and the average investor is probably down substantially.)

Gold, meanwhile, has risen approximately 170%.

We feel pretty good about our “Trade of the Decade.” So far. So good.

But the decade is not over. If Richard Russell and the bulls are right, we may regret sticking with gold for the rest of the decade. But what else can we do? Stocks are still expensive. And we doubt that the underlying trends that have pushed up gold to $700 have fully expressed themselves. The price of the metal was over $700 – if we recall correctly – the day Ronald Reagan was first sworn in as president, 27 years ago. Then, the dollar – against which gold is measured – was fundamentally much more solid than it is today. Back then, derivatives, the carry trade, private equity and diamond-encrusted skulls had scarcely even been invented.

No, dear reader…there’s no need to get fancy…no need to pay hedge fund managers 2 and 20…no need to increase risk or decrease sleep. We will stick with our “Trade of the Decade” like we stick with our business and our marriage – we want to see what happens next.

We are living here in London – continuing our tax exile from France. But we are hardly suffering. Instead, we are sharing our apartment with two daughters – both in their early 20s.

This is a new experience for us; we never imagined there were so many different kinds of shampoo.

Last night, Maria took us all to see a friend’s play in the West End. This was a new experience too…we go to the theatre fairly often, but this time we got a lifetime’s worth of the “F” word in just two hours. If you thought Americans were coarse, dear reader, you should hear the Australians!

After the show, we went with our two daughters…and practically the entire cast of the play…to a private club favored by the theatrical community.

“And look behind you, there’s ‘so and so’…he was in Cats…and then in that movie with Brad Pitt…or maybe it was Orlando Bloom.”

“Orlando Bloom was in here the other night…he’s a good friend of Paul’s…”

“Paul who?”

“Oh, you know Paul…he goes out with Suzie…”

And so it went…’til about 2 AM, when we paid the $200 bar tab and went home.

“This is life in the theatre,” explained the young woman we had come to see.

“We don’t know what happens before noon. None of us ever get up before noon. But it is a great life…at least for now. I’m the star of the show…and I’m so impressed with myself. People wait at the theatre door for my autograph. I still can’t believe it.”

The play itself was about young Australians in London. It revealed the “metro-sexual” lives that unmarried people seem to favor…which seemed a bit like the lives of the actors and actresses themselves. One lover is replaced by another one. One job is followed by another one. One party to the next. One holiday trip…and then, another trip.

It is all good fun, we suppose. But we never lived like that. We were always too busy working. Did we miss an important stage in our lives? Maybe. But we don’t regret it.

Enjoy your weekend,

Bill BonnerThe Daily Reckoning
September 7, 2007

P.S. Speaking of Harry Potter…it looks like we knocked the boy wizard from his perch at the number one slot on Amazon.com over the holiday weekend with our latest book (written with co-author Lila Rajiva), Mobs, Messiahs and Markets. Interestingly, the folks at Amazon have matched our book up with Greenspan’s recently released memoir.

Now let’s see what today’s guest essay has in store for us…

————–

The Daily Reckoning PRESENTS:

Is cash still king? Is cash even cash anymore…or is it just a Petri dish of short-term corporate debt obligations, mingled with a hodgepodge of obligations from debtors all over the world?

“During every other mini-crisis I felt like there was something worth buying, some other asset class negatively correlated to the ‘bad thing’ I thought was coming,” writes Dan, from Melbourne, Australia. “But if the credit bubble well and truly deflates (in the kind of way the Hindenburg deflated), the best place to be is with your feet firmly planted on the ground and cash in your pocket (not in the bank, or in a money market fund, or Treasuries, which should get shellacked now that Bush has proposed the nationalization of the subprime market.)

“Here’s the essential question I am asking: ‘If there is one thing you could do with your money right now to make it safer, what is it?’ My best answer is to take $1,000 cash out of the ATM and stash it in my cigar box.”

Over to Short Fuse, reporting from Los Angeles…

————–

Views from the Fuse:

*** And so the speculation continues…what will the Fed do, come September 18th?

John M. Berry, writing an op-ed piece on Bloomberg.com thinks that the United States will get a quarter-percentage point cut when the Fed next meets – and that’ll be it.

“While the Fed might decide on a rate reduction as a bit of insurance against having growth weaken too much,” he writes, “there’s no sign of serious problems in the economy outside of housing.”

Let’s repeat that again. “…there’s no serious problems in the economy outside of housing.”

Ummm…Mr. Barry, we hate to be the ones to break it to you…but have you had a look at the headlines today? Or any day recently? No? Okay, we’ll walk ya through it…

The stock market took a dive this morning on “surprising” news that August employment numbers were in decline. That’s right, today is “Jobs Jamboree” Friday, and the Labor Department reported that U.S. nonfarm payrolls fell an estimated 4,000 in August, which is the first such drop in four years.

“Today’s U.S. nonfarm payroll stunner is a likely game-changer for the Fed’s strategy in managing the credit crunch crisis, as the Fed’s internal desire to avoid reductions in the Fed funds rate target will likely need to be moth-balled for now,” wrote analysts at Action Economics.

Alright, so this is the biggest decline in four years…but a “stunner”? Really? Is no one paying attention to the lenders going belly-up? Construction slowing? All of these places had employees…at one point.

Housing is, in fact, a “serious problem” in our economy…but clearly, it isn’t only confined to the housing sector. Like everything else in economics – it’s all connected…the ripples of these kinds of problems will always be felt throughout the economy.

Yesterday, we mentioned that the U.S. keeps breaking records…but not in the good, we-just-won-gold-in-uneven-bars-AND-the-pole-vault kinda way. No, we keep breaking all the wrong records…the dollar hitting all-time lows against major currencies…record-breaking foreclosures.

But today, comes a record we can get on board with…a 16-month high for gold.

Seems like some people are realizing that they may need some sort of tangible protection against the market (and dollar) ups and downs. These are the people that look past the Bloomberg op-ed pieces and the Fed’s “Lilywhite Book” to find the truth in the marketplace.

And finally, Greenspan was splashed all over the news today – and not for promoting his new book. He’s asserted some frustration with how the new Fed chairman is running the show…

He has likened the market behavior of recent weeks to what we saw in 1998 – ““what we saw in the stock-market crash of 1987, I suspect what we saw in the land-boom collapse of 1837 and certainly [the bank panic of] 1907.”

Real quick…I’m just doing the math…but who was the Fed chairman in 1998? Ohhh…that’s right.

Addison, over at The 5 Min. Forecast, says, “Greenspan ‘expressed his frustration’ at the Federal Reserve’s inability to control these crisis’ with interest rates. Heh. He lamented the drastic hikes his fed undertook in the mid 90’s to cool the tech sector, only to watch it blow up even bigger near the turn of the century. Greenspan said he believes the same tactic wouldn’t have helped today’s crisis.

“‘The human race has never found a way to confront bubbles,’ said Greenspan, ‘and these bubbles cannot be defused until the fever breaks.’

“We’ve been noodling over Greenspan, his speeches and his actions as chairman of the Fed for years… we couldn’t have outlined our central critique any better ourselves. Why did he wait until he was retired from the post to come clean?”

About Bill Bonner:

Since founding Agora Inc. in 1979, Bill Bonner has found success in numerous industries. His unique writing style, philanthropic undertakings and preservationist activities have been recognized by some of America’s most respected authorities. With his friend and colleague Addison Wiggin, he co-founded The Daily Reckoning in 1999, and together they co-wrote the New York Times best-selling books Financial Reckoning Day and Empire of Debt. His other works include Mobs, Messiahs and Markets (with Lila Rajiva), Dice Have No Memory, and most recently, Hormegeddon: How Too Much of a Good Thing Leads to Disaster. His most recent project is The Bill Bonner Letter.